Voluntary Classification Settlement Program

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On September 21, 2011, the IRS announced and explained its new Voluntary Classification Settlement Program (VCSP) that provides partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers as employees (see Announcement 2011-64). In essence, eligible employers may voluntary elect to participate in the VCSP in order to limit federal employment tax liability for the past non-employee treatment of workers who should have been classified as employees.

In order to participate in the program, the taxpayer must meet certain eligibility requirements, apply to participate in VCSP, and enter into a closing agreement with the IRS.

Background Information

Whether a worker is performing services as an employee or as an independent contractor depends upon the facts and circumstances and is generally determined under the common law test of whether the service recipient has the right to direct and control the worker as to how to perform the services. In some factual situations, the determination of the proper worker classification status under the common law may not be clear.

For taxpayers already under the IRS examination, the current CSP may be available to resolve federal employment tax issues related to worker misclassification, if certain criteria are met. The examination CSP permits the prospective reclassification of workers as employees, with reduced federal employment tax liabilities for past nonemployee treatment. The CSP allows business and tax examiners to resolve the worker classification issues as early in the administrative process as possible, thereby reducing taxpayer burden and providing efficiencies for both the taxpayer and the government.

In order to facilitate voluntary resolution of worker classification issues and achieve the resulting benefits of increased tax compliance and certainty for taxpayers, workers and the government, the IRS has determined that it would be beneficial to provide taxpayers with a program that allows for voluntary reclassification of workers as employees outside of the examination context and without the need to go through normal administrative correction procedures applicable to employment taxes.

Effect of VCSP

A taxpayer who participates in the VCSP will agree to prospectively treat the class of workers as employees for the future tax periods. Additionally, a taxpayer participating in the VCSP will agree to extend the period of limitations on assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which the taxpayer has agreed under the VCSP closing agreement to begin treating the workers as employees.

In exchange, the taxpayer will pay ten (10) percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of section 3509 of the Internal Revenue Code. Moreover, the taxpayer will not be liable for any interest and penalties on the liability; and will not be subject to an employment tax audit with respect to the worker classification of the workers for prior years.

Contact Sherayzen Law Office NOW to Resolve Your Employment Tax Issues

If you wish to find out whether you are eligible to participate in the VCSP and whether this is the best option for you, you should contact Sherayzen Law Office immediately. Our experienced tax attorneys will guide you through the complex process of Voluntary Classification Settlement Program and strive to achieve the most satisfactory and efficient resolution of your case.

Recent Developments in Transfer Pricing

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The IRS is currently examining new procedures and policies regarding transfer pricing audits. Recently, the IRS developed a “Transfer Pricing Practice” within its Large and Mid-Size Business (LMSB) operating division, and last August, the IRS realigned its Large Business & International (LB&I) operating division to handle international tax matters more effectively. The Service intends to employ experienced international transfer pricing examiners, Advanced Pricing Agreement Program staff, attorneys, economists, and other experts within the Transfer Pricing Practice to better identify emerging issues and handle such cases in an efficient manner.

The IRS is currently using a pilot program to test the Transfer Pricing Practice until official procedures and policies are developed. According to Michael Danilack, Deputy Commissioner LB&I, in a recent speech, the official practice is expected to be implemented in the very near future. Cases are being selected under the pilot program for broad, strategic impact and likelihood of success in order to identify key issues.

It should also be noted that the IRS recently decided not to appeal a loss in an important transfer pricing Tax Court case, Veritas v. Commissioner, involving the transfer of intellectual property to a wholly-owned foreign subsidiary under a cost-sharing agreement. The Tax Court ruled against the IRS, holding that Symantec Corp. (the acquirer of Veritas Software Corp.) owed no tax, penalties or interest. Although the IRS did not appeal, it did issue an Action on Decision stating that the court’s factual findings and legal assertions were erroneous. Furthermore, IRS Commissioner Doug Shulman gave a speech shortly afterward saying that the adverse decision would not limit the IRS’ intent to challenge other transfer pricing issues in the future, should they arise.

Additionally, in Congress, the House Ways and Means Committee recently scheduled a rare hearing on transfer pricing, and intends to examine the issues this year.

Contact Sherayzen Law Office NOW for Legal Advice on Transfer Pricing Agreements

This article is intended to give a brief summary of these issues, and should not be construed as legal or tax advice. If you have further questions regarding these matters as it pertains to your own tax circumstances, Sherayzen Law Office offers professional advice in all of your tax and international tax needs. Call (952) 500-8159 to discuss your tax situation with an experienced business tax lawyer.

Small Business Health Care Tax Credit

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This is a Small Business Health Care Tax Credit update from a tax attorney in Minneapolis.

Generally, the Small Business Health Care Tax Credit is available to small employers that pay at least half of the premiums for single health insurance coverage for their employees. It is specifically targeted to help small businesses and tax-exempt organizations that primarily employ moderate- and lower-income workers.

The credit can be claimed by small businesses during the tax years starting 2010 through 2013 and for any two years after that. The maximum credit is 35 percent of premiums paid by eligible small businesses and 25 percent of premiums paid by eligible tax-exempt organizations. Beginning in 2014, the maximum tax credit will increase to 50 percent of premiums paid by eligible small business employers and 35 percent of premiums paid by eligible tax-exempt organizations.

The maximum credit goes to smaller employers –– those with 10 or fewer full-time equivalent (FTE) employees –– paying annual average wages of $25,000 or less. The credit is completely phased out for employers that have 25 or more FTEs or that pay average wages of $50,000 or more per year. Since the eligibility rules are based in part on the number of FTEs, not the number of employees, employers that use part-time workers may qualify even if they employ more than 25 individuals.

Eligible small businesses should first use Form 8941 to figure the credit and then include the amount of the credit as part of the general business credit on its income tax return.

If you have any questions with respect to eligibility or calculation of your small business health care tax credit, contact Sherayzen Law Office to discuss your case with an experienced Minneapolis business tax attorney!

S Corporations: Excessive Passive Income Penalty and Built-in Gains Tax

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Corporations that make valid election to be taxed under Subchapter S (“S corporation”) are treated as pass-through entities.  This means that the S corporation’s gains, losses, income and expenses are passed onto shareholders who will pay the applicable federal income taxes; the S corporation itself does not pay any taxes (as opposed to a regular corporation taxed under Subchapter C (“C corporation”)). However, there are two fairly common circumstances in which an S corporation may have to pay taxes: the excessive passive income penalty and the Built-in-Gains tax (Note that for the few S corporations that utilize the Last-In-First-Out (“LIFO”) inventory accounting method, and also previously operated as a C corporations before electing to become S corporations, a LIFO Recapture Tax may be applied in certain situations).

Excessive Passive Income Tax and Penalty

There are situations where S corporations may have previously operated as C corporations before their conversion. In some circumstances, after conversion, the S corporation still retains profits that it made as a C corporation. These profits are called “Accumulated Earnings and Profits” (“AEP”).  Since an S corporation does not usually pay taxes at a corporate level, one can see that a C corporation would be able to avoid taxes at the corporate level on AEP by simply converting to an S corporation. In order to prevent C corporations from taking advantage of these status conversions, Congress imposed a steep penalty (or tax) on an S corporation’s AEP.  Moreover, in some situations, an S corporation status may even be terminated.

Here is a general summary of the AEP tax. If an S corporation has AEP and “net passive income” exceeding 25% of its gross receipts in a taxable year, an excessive passive income penalty is imposed at the highest corporate tax rate on the lesser of taxable income or excess net passive income. Passive investment income consists of gross receipts from dividends (with certain exceptions), interest, capital gains, royalties, rents, and other related sources of income.

Furthermore, S corporation status is automatically terminated if an S corporation is penalized with the excessive passive income tax for three years in a row.

Built-in Gains Tax

In general, if an S corporation, that operated as a C corporation prior to its conversion, sells or distributes assets that it held during the time in which the entity was a C corporation for an amount above the adjusted basis, the resulting recognized gain (“Built-in Gains”) will be taxed at the highest corporate tax rate. The Built-in Gains will be taxable if recognized at any time within ten years after the effective date of an entity’s S corporation election. For purposes of the Built-in Gains tax, assets held during the entity’s existence as a C corporation and distributed after conversion to the S corporation’s shareholders for an amount above the adjusted basis will be treated as if these assets were sold.

As with the excessive passive income penalty, the Built-in-Gains tax is designed to prevent a C corporation from avoiding taxes by converting to an S corporation status and then selling or distributing appreciated assets. This is because for C corporation, recognized gain on sales of appreciated assets would be taxed at the corporate tax rate, whereas for an (traditional, non-converted) S corporation, the gain would be passed to the shareholders (likely on a pro rata basis), who will pay the tax based on their individual income tax rates, which may be lower than the C corporation’s tax rates.

The calculation of the Built-in-Gains tax is fairly complex, with a computation involving a determination of net gains, Net Operating Losses and loss carry forwards from years the entity operated as a C corporation, general business credit carryovers from C corporation years and the special fuel tax credit, as well as other items. Furthermore, due to accounting complications, converting from a C corporation to an S corporation may result in some unanticipated items, such as accounts receivable, being treated as Built-in-Gain and subject to tax.

Conclusion

Are you thinking about converting a C corporation to an S corporation, and concerned about possible taxes that your business may face if doing so? Are you looking for legal tax strategies to best structure a conversion, or to handle transactions with an already converted S corporation in order to limit your company’s taxes? Give Sherayzen Law Office a call to discuss your tax situation with an experienced Minnesota business tax lawyer.